TFG’s Quarterly House Piece

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Dear Friends,
The markets continue to shock and awe. Aside from the entertainment value of cryptos and other asset classes bouncing around, there sure is plenty to keep an eye on. With that in mind, see below three themes we are watching closely for Q3 2021, as well as our current asset allocation tilts.
I. The Reflation Trade: Making it’s Way to Europe?
As we’ve covered in previous investment updates, the Reflation Trade is a term used to describe the broad economic rebound in 2021, highlighted by the rollout of the vaccine, substantial GDP growth, and an accommodating Federal Reserve. As we’ve seen the Reflation Trade play out in the US, we have begun to see early signs of a Reflation Trade also gaining steam in developed countries (specifically in Europe).
While Developed Europe has seen strong GDP growth and interest rates stay near-zero (and even negative in several countries), the poor execution of the vaccine rollout set them several months behind the US in the broad recovery. Now that the rollout of the vaccines has picked up, investors have started to become more enthused with the region. On top of that, many stalwart companies in Europe are available at very attractive valuations.
Implementation:
We believe that Developed Europe will experience a rebound in the second half of the year similar to the rebound that the US experienced in the first half, and have positioned our in-house investment models and client portfolios to reflect that. We utilize active managers in this area as they will have the flexibility to tactically allocate their fund’s assets to attractive opportunities as they arise.
II. China & Emerging Markets: Choppy Seas Ahead
Emerging Markets equities have been a hot topic of conversation in the investment world in 2021, as the asset class has swung wilding in performance seemingly on a weekly basis. After an explosive first six weeks of 2021 where the MSCI EM index returned +11%, the Index has seen significant consolidation. EM now lags every major equity index on a year-to-date basis (up only +4% year to date versus +17% for the S&P 500 and +14% for the MSCI Global Index).
The primary cause of the volatility is related to the crackdowns on the large Chinese tech firms by the Chinese government. The crackdowns have been presented to be in favor of competition and preventing monopolies. However, many would argue that the crackdowns are a tool of the Chinese government to flex their muscles and show their influence. In short, the Chinese government presents a risk to Emerging Markets that cannot be forecasted and one that can swing an entire index due to China’s presence in several major indexes. For example, China makes up approximately 38% of the MSCI Emerging Markets Index, which presents a significant risk if Chinese companies continue to be bullied by their own government.
*Performance data is from Morningstar.com and as of 7/22/2021*
Implementation:
Although we still believe Emerging Markets will perform well over the long term, the current political risks in China have led us to pull back on our position in EM across various investment models. For the assets remaining in EM, we have focused on funds that can quickly adapt positioning to reduce political risk. Passive Emerging Markets index funds simply cannot allocate away from China based on how they’re structured.
It is also important to note that Emerging Markets companies have continued to struggle with vaccine rollout, but we believe that is a temporary issue that will eventually be resolved.
III.  US Growth vs. Value Update
As discussed in previous editions of the House View, the Growth vs. Value debate within US equities has continued into the second half of the year as Treasury rates continue to fluctuate and concerns about the Delta variant of Covid-19 have heated up. Value equities dominated their Growth counterparts for the first 6 months of the year, but Growth has recently begun to surge back and is now nearly tied with Value on a year to date basis:
Growth vs. Value Performance Comparison
  • 1/1/2021-6/1/2021:
    • US Growth: +9.5%
    • US Value: +20.4%
  • 6/1/2021-7/22/2021:
    • US Growth: +8.5%
    • US Value: -1.6%
  • Year to date (1/1/2021-7/22/2021):
    • US Growth: +16.8%
    • US Value: +17.1%
*Performance data is from Morningstar.com and as of 7/22/2021*
The resurgence of Growth over the past 7 weeks can be credited to the continued fall of Treasury rates (10-year Treasury rate currently at 1.26%), fears of the Delta variant, and exquisite earnings from growth companies.
Moving forward, we believe that interest rates will eventually begin to move up as the economy continues its recovery, which we believe will lead to outperformance of Value companies over Growth in the short to mid-term. With that said, we are maintaining a balance between Growth and Value as the Growth sector still contains excellent companies with bulletproof balance sheets and long-term competitive advantages in their respective industries.
Implementation:
As mentioned, we have maintained a balance between Growth and Value within our in-house investment models, both in domestic equities and international equities. In addition, we have kept our allocations to Small & Mid-Cap companies as we believe they will continue to benefit from the economic recovery over the next 12-18 months.
Pulling It Together: Asset Allocation Recommendations
  • Overall: Overweight stocks relative to bonds when risk tolerance allows
  • Equities
    • Balanced Value and Growth
    • Overweight International (Developed Europe) and Underweight Emerging Markets (short-term)
    • Balanced US Large, Mid, and Small Cap
    • Balanced US and Global overall
  • Fixed Income
    • Overweight Multisector and Convertible bonds, reviewing Emerging Markets Bonds
    • Underweight “Core” bonds, including Treasuries
    • Balanced Investment Grade and High-Yield
We will continue to frequently review portfolios to ensure that they reflect our best and most current ideas. As always, if you have any questions or would like to discuss the above topics further, please do not hesitate to contact us.
  • MSCI Emerging Markets – Designed to measure equity market performance in global emerging markets. It is a float-adjusted market capitalization index.
  • S&P 500 – A capitalization-weighted index of 500 stocks designed to measure the performance of theÛroad domestic economy through changes in the aggregate market value of 500 stocks representingÚll major industries.
  • Investors cannot invest directly in indexes. The performance of any index is not indicative of the performance of any investment and does not take into account the effects of inflation and the fees and expenses associated with investing.
  • The views stated in this letter are not necessarily the opinion of Cetera Advisor Networks LLC and should not be construed directly or indirectly as an offer to buy or sell any securities mentioned herein.  Due to volatility within the markets mentioned, opinions are subject to change without notice. Information is based on sources believed to be reliable; however, their accuracy or completeness cannot be guaranteed.  Past performance does not guarantee future results
  • Additional risks are associated with international investing, such as currency fluctuations, political and economic stability, and differences in accounting standards.
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